Liquidity Driven, But Still Discounting Recovery    

• Just as investors were bracing for a (healthy) interim correction, the market refused to go down. Smart investors continue to insist that the 58.4% rebound from March lows in the S&P 500 has come too far, too fast, and is not justified by earnings or economic fundamentals. Stock prices continue to discount something that is not yet visible to investors, or that they refuse to believe.
• The key question remains to be, can this rally be maintained without extraordinary government intervention? The prognostications by the bears are interesting, but so far have been of little use since the March lows.
• The bears take the line that the unprecedented actions of governments and central banks i.e., enormous deficits, near-zero interest rates and “quantitative easing” may have kick-started the global temporarily back to life, but these actions have not solved the underlying causes of the mess. The issue is excessive debt. Consumers and companies, and increasingly, developed nations. In particular, they worry that a deleveraging of this debt will quickly stamp out any recovery, with the template being Japan’s experience from its Heisei Malaise.
• Governments of course are counting on their stimulus enhancing the economy's ability to right itself and solve the problem of excessive debt with the profits generated from a return to trend growth.
• Markets rarely unflold as well as the "outlier” bulls insist, or as badly as the “outlier” bears insist. Our most likely compromise scenario is for a modest interim correction at some point, followed by a period of sideways trading like the post IT bubble market in 2004. The period of sideways trading will be needed for the market to sift gears from being driven by excess liquidity to earnings-driven fundamentals.
• Both global, S&P 500 and Japan Topix sector performance is being led by basic materials and technology, i.e., economically sensitive sectors?the strong implication being that, a) the recovery continues to unfold and b) there are strong expectations that this recovery will bring accelerating inflation with it.

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